OceanFirst Financial Corp. (OCFC) Q2 2017 Earnings Report, Transcript and Summary

Good morning and welcome to the OceanFirst Financial Corp. Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please also note that today’s event is being recorded. I would now like to turn the conference over to Ms. Jill Hewitt. Please go ahead.

Thank you, Andrea. Good morning and thank you all for joining us. I'm Jill Hewitt, Senior Vice President and Investor Relations Officer at OceanFirst Financial Corp. We will begin this morning’s call with our forward-looking statement disclosure. Please remember that many of our remarks today contain forward-looking statements based on current expectations. Refer to our press release and other public filings, including the Risk Factors in our 10-K, where you will find factors that could cause actual results to differ materially from those forward-looking statements. Thank you. And now, I will turn the call over to our host, Chairman, President, and Chief Executive Officer of OceanFirst Financial Corp., Christopher Maher.

Thank you, Jill, and good morning to all who have been able to join our second quarter 2017 earnings conference call today. This morning, I'm joined by our Chief Financial Officer, Michael Fitzpatrick; Chief Administrative Officer, Joe Iantosca; and Chief Banking Officer, Joe Lebel. As always, we appreciate your interest in our performance and are pleased to be able to discuss our operating results with you. As has been our practice, we will highlight a few key items and add some color to the results posted for the quarter and then we look forward to taking your questions. In terms of financial results for the second quarter, diluted earnings per share were $0.23. Quarterly reported earnings were impacted by branch consolidation charges and merger-related expenses of $0.17 or $5.6 million after-tax, resulting in core earnings per share of $0.40. Regarding capital management for the quarter, the Board declared a cash dividend of $0.15, the company's 82nd consecutive quarterly cash dividend. No share repurchases were made during the quarter leaving 1.8 million shares available to repurchase. Given our decision to acquire Sun Bancorp, share repurchases are unlikely in the coming months as our ways will be towards building capital levels to support potential balance sheet growth following the Sun acquisition. Turning to organic growth and the overall operating environment, second quarter loan originations were strong at $215 million including $115 million of commercial loans with a weighted average yield of 4.52%. Net loan growth is modest as we maintain price discipline and continue to take advantage of opportunities to improve credit quality as the acquired loan portfolios mature. The total loan portfolio increase of $47 million occurred late in the quarter producing a minimal increase in interest income or was a welcomed improvement from the $27 million of total growth in the first quarter of 2017. Our strategy continues to favor steady and consistent loan growth as we invest our excess liquidity position overtime. Deposit performance was stronger than the headline number indicates due to a seasonal run down in our government banking business. The seasonal government deposit run down matched healthy trends in retail and business deposits. On a year-to-date basis, retail core deposit growth was modestly positive at $4 million and non-government business core deposit growth was stronger totaling $22 million. That performance is particularly notable given the consolidation of 15 retail branches over the last 90 days which creates the risk of deposit run off. The branch consolidation project began this time last year as we carefully evaluated locations, facilities and potential customer impacts. After making thoughtful decisions in the fourth quarter of last year, our staff commenced client communications in February of this year. They’ve done an outstanding job during every step of the process. I’m quite proud of the retail, marketing, operations and technology team that achieved the consolidations on time, on budget and with a bare minimum impact to customers. While it’s still early, all indications are that the branch consolidations are exceeding our expectations as customer retention levels are high and we are on track to achieve the efficiencies originally envisioned for this project. The project cost remained stable rising just 1 basis point. This modest increase was related to product mixed shift rather than any increase in deposit rates across the portfolio. The net interest margin was stable increasing a basis point this quarter. The improvements in asset yields were offset as purchasing accounting benefits decreased by 3 basis points and prepayment income decreased by 1 basis point. The interest rate environment including the slope of the yield curve has been fluid and the impact of potential balance sheet reductions at the federal reserve can’t be known with any precision and this environment will maintain a balanced interest rate risk position and continue to dollar average our investments in both the loan and security portion of the balance sheet. We have worked on the bank’s cash position by just about $200 million since year end. We have over $100 million in cash currently available and our loan to deposit ratio is a conservative 93%. With an expected seasonal increase in government deposits beginning in the third quarter, we anticipate having ample liquidity to support loan and securities growth in the coming quarters. Operating expenses excluding merger and branch consolidation expense decreased by $954,000 as compared to the prior quarter driven by compensation expense reductions. This decrease represented a portion of the efficiencies we expected to achieve as part of the Ocean City Home Bank acquisition. Additional efficiencies will now be realized as the full integration of Ocean City Home was completed in May with many of the separated staff working through June 30. As a result of the Ocean City Home systems integration and the branch consolidation project, third quarter expenses are expected to decrease by an additional $1.8 million on a pretax basis. As of the third quarter, the efficiencies anticipated as part of the Ocean City Home acquisition will be fully realized and compared favorably to our original projections. Of course additional tuning of our operations will result in marginal improvements in efficiency but those additional improvements won’t be significant and they will be offset by some expenses that will be required as the consolidated back office facility. As previously mentioned, we currently have backlog to staff operating at 13 locations distributed throughout our market. We’ve been working diligently to determine the best solution to consolidate staff and continue the cultural integration. That issue has become even more important in light of the pending Sun acquisition which brings another six sites into consideration as part of the backlog consolidation project. I would expect that the consolidation of backlog locations will be determined in the third quarter for implementation in 2018. Depending on the final solution, the bank will either purchase or release the suitable location to accommodate current and future space needs. In terms of asset quality, credit performance was strong as non-performing loans decreased $5.4 million or 25%, now totaling just 42 basis points of total loans. The reduction in non-performing loans was achieved through a combination of a small residential loan sale and two non-performing commercial loan tails totaling $1.7 million which represented full recoveries. Excluding the residential loan sale which resulted in $925,000 charge off, the remaining loan portfolio experienced a quarterly network covering of $166,000. The provision of $1.2 million resulted in a $400,000 net increase to the allowance primarily to cover quarterly loan growth. Regarding the pending acquisition of Sun Bancorp, the timeline discussed at our recent acquisition conference call remains on track. As this acquisition continues to advance the development of our commercial banking business, we have decided to make the application to the Federal Reserve and to the office of the controller of the currency to convert our holding company to a bank holding company and our bank to a national bank concurrent with our acquisition of Sun. The additional step will likely add some time to the decision process or will serve us well in the future and the requested charter structure more closely reflects our long term strategy. We expect to file our regulatory application at some point in August using the June 30 call report data from both institutions. Based on the required approvals and application timeline, we would target that Sun acquisition could close in early 2018. The acquisition of Sun should cement our competitive position in central and southern New Jersey while providing a platform that will produce greater efficiencies and better operating scale. In summary, this is an important quarter for the company. Performance for the second quarter was solid with a core return on assets of 1.02%, core return on tangible common equity of 12.42% and a core efficiency ratio of 58.04%. These performance metrics are positioned to improve materially in the third quarter as expenses were trending down and there is currently no significant pressure on margins during credit cost. We were able to improve the rate of organic growth, deliver on the efficiencies and promise from the Ocean City Home acquisition and demonstrate improving asset quality. With the Sun acquisition, we’ve set the stage for incremental progress in 2018 and beyond. At this point, Mike, Joe, and I would be pleased to take your question this morning.

We will now begin the question-and-answer session. [Operator Instructions] And our first question comes from Dave Bishop of FIG Partners. Please go ahead.

Hey, good morning, gentlemen.

Good morning, Dave.

Hi, Dave.

A question circling back to the outlook for deposits and maybe some of the trend this quarter. Maybe just walk us through I don’t know if you can sort of bring sense of the dollar amount tied to the seasonal run off and maybe sort of expectations for how much backfill there on the deposit front and was that across both noninterest bearing and some of the other core deposit segments?

So, I’ll talk a little bit about momentum and then Mike may add some numbers to give you some perspective. But the government deposit business for us is very much about operating accounts. So we are handling cash management accounts for everything from municipality to school districts and there is a seasonality to when those tax payments are made, typically picks up beginning in late July and gets quite heavy through August and September probably peaking in the fourth quarter and then starting to come down again in the beginning of the year. So we certainly expect to see positive deposit flows as we have in the past. We’ve not lost any client so these are just existing accounts that are drilling down the balances. The second thing is although the seasonal business is in joint for us, we do have a bit of a seasonal business being a shore oriented bank and typically OceanFirst had a little bit of a positive flow of deposits going to the third quarter. And I think with the addition of Cape and Ocean Shore, those were also seasonal to the same degree. So they would have seen deposit peak sale in the September, October timeframe as kind of the season finished, the merchants and commercial entities at the most cash. So we expect deposit flows could actually be quite material in the third and fourth quarters. Mike I don’t know if you have any numbers, you add to that.

As you look at last year with the same trend, we see the second and third quarter, they were substantial growth. So, as Chris said, contributed to the seasonality of the government and the [indiscernible] economy.

Got it. So thus far from a maybe from a municipal perspective, are you seeing much – we’re hearing some of the banks across the northeast talked about some of the local municipalities and school districts and public funds so to speak come back and really start beat you all up for increase in the deposit pricing. Are you seeing much of that phenomenon as of yet, it doesn’t look like from your cost of funds but if any of that was underneath the surface at all.

So, there is several different segments of the government deposit business and you have different kinds of entities like school boards and municipalities and utility authorities. And then within those entities, you have very different investment instruments. So there will be what I’d call high rate money market or CDs as typically gets it around and certainly on the big money which tends to be CVs and more money market, you’re seeing more competition, that’s not new, that’s been going on for the last probably two to three years where look we got a couple of million dollars and they want to put way for six months or a year. Those can be bid to market rate. Most of our business has been the cash management, operating accounts, payroll accounts, that’s a different kind of a business. Those tend to be in accounts that are less sensitive to interest rates. So I’d say that zero sensitivity, but as you can tell from our cost of funds, we’ve been able to retain the relationships without a lot of pressure on deposit cost. Those are very – these are accounts that are not easy to move, right. You’ve got a ton of ACH activity, wire activity, you’ve got remittances in terms of municipal tax payments. You’ve employees of the municipalities of the school board where you need a branch network to go in, so not uncommon for some of these folks to have requirement, but you don’t have a branch within their municipality, you are not allowed to bid. So, there’s a couple of barriers around the operating accounts that are different from the investment accounts.

Got it. That’s good color. And then sort of going back to expenses, I think I heard you right, did you say the third quarter you are expecting the run rate to be – was it $1.7 million, $1.8 million below second quarter on a core basis or is that $1.8 million annualized?

That’s $1.8 million in the quarter pre-tax.

All right. Thank you.

Thanks, Dave.

Our next question comes from Matthew Breese of Piper Jaffray. Please go ahead.

Good morning, guys.

Good morning, Matthew.

I had a few question. One, Chris, maybe you can just talk about the liquidity position of the bank, obviously there is a little bit more in the securities portfolio, you are still holding on to quite a bit of cash, could you talk about that in light of your commentary regarding the fluid yield curve and then maybe tying that into the margin if you are holding onto extra liquidity, how detrimental the margin do you think it is?

Sure. So a couple of things, the – well, we are very pleased with the performance of the branch consolidations. The prudent thing to do is to model some attrition when you go into branch consolidations. And if you are modeling attrition, you are going to keep a little extra cash around to make sure that you funding any attrition that may come out of your cash position and not happen to cover that as borrowings or something so – but I would say that we’ve been purposely managing to have a little excess cash around for that purpose. Thus far we are very pleased with that whole project. It doesn’t look like we are going to have any measurable attrition. And I think the customer notifications began first last year when we made the acquisitions, then you are sending letters out in February. This is not something that just happened last week. These are process we’ve been working through with customers for quite some time, the conversion of the Ocean City Home folks in May. So in terms of liquidity, we kept a little bit of extra cash around. I think we’ve got the option to use that. My comments earlier are we expect cash flows to be positive over the next couple of quarter. My comments about the Federal Reserve and the uncertain interest rate environment are just that we want to make sure that we maintain a balanced interest rate risk position and that – this principal dollar average you are getting is very important for us. So we don’t feel that institution like ours should be taking interest rate bets [ph], so we are not trying to dump all the money into an investment in any given quarter. So I think you are just going to see us dollar averaging. Implications for the margin are relatively benign. I think we have a general – we have a positive impact on margins that’s coming out of the deployment of cash. On the negative side, we’ve fully planned for the purchase accounting benefits to wind down over the next eight quarters or so, they start to tail off after that. So every quarter – last quarter it was about three basis points of purchase accounting decrease which we overcame with a little of growth in the right yield. I think you are going to see the margin bounce around where it is, maybe up a couple of points here and there from quarter to quarter, but no significant pressure nor would I see it move significantly higher with one caveat. We’ve seen the long end of the curve has been bouncing around this year with no real I wouldn’t say kind of firm direction. If you got steepness to the yield curve and we maintain our cash position, we would then have the option at that point to lock in some better margins. At that point, you might see the NIM expand a little bit more meaningfully.

Got it. And then on the loan growth side, what are your expectations for annualized loan growth for the reminder of the year?

Matthew, Joe Lebel. I think we expect the same type of growth that we are seeing, low-to-mid single digit loan growth for the rest of the year. We are very happy with the originations and we temper that by doing what we’ve always done, which is look really closely at the correct metrics in the book and the acquired book and make sure that those acquired loans meet the criteria that we set for ourselves.

Okay. Could you walk us through the implications of the chatter change, why you are doing it, are there any implications for the P&L or balance sheet, anything we should be prepared for on our end as analyst/investors, or is it more something you need to do as the balance sheet changes?

Sure. That’s a great question. So the primary driver, it is not an urgent matter, but it is a building matter has been that our thrift chatter comes with it the qualified quality thrift lender test which says that we’ve got a certain portion of our assets have to be thrift qualifying assets. A couple of things have benefited from that thus far. The first is that smaller dollar commercial loans count towards the residential test and CRA qualifying loans which we make a lot of count double through the test. So although the balance sheet has a good proportion of commercial loans on it now, we continue to qualify under that QTL test. On a pro forma basis as we put the company together with Sun, we will be getting close to that test. So now we could complete the Sun acquisition without doing a charter change, but then the runway thereafter especially given our intent to be a much more commercial bank could be restricted. And when you get to that point banks start to make decisions over continuing to pass the QTL test by buying securities or manipulating your balance sheet in other ways. And that’s not something we want to get ourselves into a trap around. And that’s not something – look if we completed the Sun acquisition early 2018, it wouldn’t happen right away or probably within four, eight quarters should start to really feel the pressure over the QTL test. That’s the primary reason that we are considering to change. And this is something that as long as you are filing a regulatory application, you have the opportunity to do a simultaneous application of both of these things. In terms of implications for investors, I think it’s relatively benign, we would have the same regulators of the [indiscernible] OCC supervise today. Fed Reserve looks at the thrift holding company today, so it’s the same regulators coming out the other end of the transaction. So, it really doesn’t change your cost structure, there is no statutory changes that would make much of a difference to us. There are some nuances to the difference in the charters, but they don’t apply to the things we are dealing as an operating business today. So there are certain business a thrift could engage and a national bank couldn’t and then a national bank is allowed to carry a higher level of commercial assets. So I think from an investors perspective, the only material thing is that, we may be adding – it’s hard to say whether it’s four, six, eight weeks to the regulatory process because there is a parallel process going on as they consider things. So, we thought the timing was right, we thought it reflects where we are going with the company. More academic discussion is about whether one charter gets a better multiple than the other, but I’ve always believed that your balance and earnings stream will determine that.

Understood. Very good. That’s all I have. Thank you very much.

Our next question comes from Frank Schiraldi of Sandler O’Neill & Partners. Please go ahead.

Good morning.

Good morning, Frank.

Just wondered if you – Chris, I’ve heard just talking about consolidating the back office, I’m just wondered if you had thoughts on savings from there or should we just think about that as part and parcel again to sort of pro forma 50% efficiency ratio over time?

Yeah, I think, it’s all wrapped up in that 50% efficiency ratio over time. Certain line items might get more expensive right because if you are going out to sign a lease or buy a property, you may incur certain expenses there, so of the facilities that we exit, we will be able to take expenses out right, because they are back office facilities, you can exit them and you save money. Other are we’ve got people in dual purpose facilities where you may have a dozen people upstairs from a branch, that’s not ideal from an operating efficiency standpoint. But you are not going to save that much money on that office if you consolidate it. So I don’t think it has a big impact one way or the other, but there surly going to be some efficiencies and some new spends. I would just think about the guidance around the efficiency ratio is where we are targeting to get to.

All right, okay. And then kind of higher level, just wondering if you could talk a little bit about the opportunities you see in the Philadelphia area and are those – is that sort of the next area to think about or consider M&A and where do you see that maybe grope that piece possibly growing to over time as part of the overall franchise?

So, we very much like the opportunity to diversify our geography a little bit. We’ve historically been – our roots are its kind of a sure concentrated bank. Then we’ve diversified that a fair amount over the last two years and we look to be able to further diversify in the coming years. What that means for us is we get certain geography right to the south and east of us are ocean so we can’t go there, so all we can do is consider going north or going west. And going north has its own challenges, there are formidable competitors in North Jersey and the New York City Metro. There is a lot of unleveraged capital in those markets, so there is a heavy degree of competition. I think also as you look at deposit funding cost, certainly the competition around deposit funding cost is brisker in North Jersey and Metro New York that is our core market today. So it’s a deep market, it’s a great market, if we had the opportunity to do more in the north, we would. One of the things we loved about the opportunity to acquire Sun is they have a commercial lending team in Edison, they’ve got a commercial lending team in Manhattan, we intent to keep those capabilities and continue to build portfolio there. On the west side as you get through go from Monmouth county where we are heavy today through Middlesex, Mercer, Bucks county and then into metropolitan Philadelphia we see great opportunity there. We’ve seen opportunity in a similarly strong urban centric environment. It’s not as large as the New York City Metro but one way there are fewer competitors, there is less excess capital position leveraged out there and there is a nice set up of competitors where you’ve got a couple of very large competitors which we typically try and compete against by service, price and flexibility, and then a number of smaller competitors where we compete against them with capability in the commercial side, very difficult for a small bank to city. So truly situational on an organic basis, you will see us growing a little bit in the New York Metro, you will see us growing little bit more in the Philadelphia Metro, that all happened quarter-after-quarter-after-quarter. And in terms of M&A, we’ve always just kind of looked at the landscape and thought about what those opportunities are in any given time. Right now, we are focused on taking care of the Sun acquisition. We’ll pick our heads up and think about that afterwards.

Great. Thank you.

[Operator Instructions] Our next question comes from Don Koch of Koch Investments. Please go ahead.

Gentlemen, thank you for your good report. I’m delighted that you’ve made the decision to go from a mutual – savings and loan to a commercial bank. And looking at your footprint, have you ever thought about doing some kind of – on a strategic sense, doing some kind of zip code analysis of why your client base migrates to and have you ever thought about having some kind of function in Florida where you have several hundred thousand people that migrate sometime there is sort of the snowbird population and you give them sort of a national bank access. So if they go to Sarasota or St. Petersburg from the New Jersey shore in the winter time, they can still have that familiar banking with Ocean?

Thanks for the question. This is certainly a strategy that many banks have employed over the years and some of them quite relevant. It’s a strategy [indiscernible] focused on for a number of years now in terms of being able to provide both ends of that seasonal migration. Real things out and certainly Florida is a higher growth state and has certain attributes to it that are really favorable. Right now, I think we’re focused on making sure that we are the best bank we can be in our geography and I have recall a mentor I worked for years ago who said, make sure you do all the business you can where you are before you get on a plane fly somewhere else. So in this area for now, but overtime we never know what the opportunity is.

That’s a good answer. The second question, second part of that is that, in the next six months, are you presenting anywhere, any seminar?

Yes. We regularly presented Investor Conferences and if you want to contact us after the call, we’ll make sure you get on the watch for that so you have the opportunity to meet up with us.

Okay. Thank you, Joe.

Thank you.

[Operator Instructions] It appears to be no further questions at this time. This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Christopher Maher for any closing remarks.

Right, thank you. Once again thanks everyone for joining us this morning for the call. We look forward to presenting additional updates as the year progresses. Thank you.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.